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In the Headlines-January 23rd, 2015

In The Headlines

Is the U.S. Vulnerable to Deflation?

Deflation is like a black hole, sucking seemingly everything into itself. Switzerland succumbed to the vortex last week when its central bank gave up trying to keep its currency from rising—a defeat that will punish the Swiss economy by making the nation’s goods more expensive on world markets.

Could the U.S. be next? The U.S. dollar is up about 11% since last summer, a rise that makes American-made goods less competitive. And there is a whiff of deflation in the air with the news that the U.S. Consumer Price Index fell 0.4% in December from the previous month, the biggest decline since the economy was in free fall six years ago. “Deflationary pressures continue to build,” Scott Anderson, chief economist at Bank of the West, wrote in a report that cited a drop in import prices and came out before the news about the Consumer Price Index.
The bottom line is that the U.S. is probably safe. The economy is strong enough that it is likely to withstand the deflationary drag emanating from Europe. The U.S. should expand a little more than 3.1% in 2015, better than the estimated 2.4% this past year, according to the median forecast of economists surveyed by Bloomberg.

But that does not mean there is no risk. Deflation is dangerous because it can travel across international borders. Europe’s economy is chronically weak. With demand for goods and services weak, prices in the euro zone fell 0.2% over the past year. The European Central Bank is widely expected to try to revive growth by buying bonds to drive down interest rates. That makes the euro a less attractive currency for investors, sending them to other havens, whose currencies are rising. That is why the Swiss franc and the U.S. dollar are getting more expensive and less competitive. In effect, if Europe’s strategy is a success, it will improve European growth at the expense of growth in the U.S., Switzerland, and elsewhere.

Economists knew that falling gasoline prices would cause the overall price index to decline in December. What they did not expect was the weakness in the “core” index, which excludes food and energy. The core index was flat compared with November’s, while the median expectation was for a 0.1% increase. Prices of apparel, vehicles, and airfare fell in December.

Inflation that is well below the Federal Reserve’s 2% target will make it harder for the inflation hawks on the Federal Reserve’s rate-setting committee to justify raising interest rates this year. “Our expectation is that the policy debate is heating up as inflation cools off,” the U.S. economics team of Bank of America Merrill Lynch wrote in a client note. On the other hand, the hawks can argue that the tightening of the U.S. labor market will push up wages this year and eventually put upward pressure on inflation. Paul Dales, senior U.S. economist at Capital Economics, wrote that lower prices for energy and imports “won’t have much of an impact on services inflation, which makes up 75% of the core index.” He notes that prices of shelter and medical care did rise in December.

“One positive from low inflation is that it is boosting workers’ real (inflation-adjusted) earnings. With the big drop in gasoline and other energy prices, workers’ paychecks are going farther, allowing them to boost their spending on other goods and services,” Gus Faucher, senior economist at PNC Financial Services Group, wrote in a report today. Indeed, the University of Michigan preliminary consumer sentiment rose this month to its highest level in 11 years.

The Booming Solar Industry Becomes a Job Creation Engine

Installers, panel makers, and even traditional fossil fuel energy companies helped U.S. solar employment grow nearly 22% in 2014. SolarCity, the largest installer of residential solar systems in the U.S., nearly doubled its workforce last year, hiring 4,000 people to do everything from system design and site surveys to installation and engineering. The hiring spree at SolarCity is not slowing; it is picking up speed as the company attempts to install twice as many rooftop solar systems than last year and readies its 1.2 million-square foot factory in New York, which is scheduled to reach full production in 2017.
SolarCity plans to eclipse 2014’s hiring numbers, according to CEO Lyndon Rive. In 2016, SolarCity will hire “quite a bit more” than it will in 2015, Rive says, though he did not provide specific numbers. The company’s expansion is indicative of what is happening within the broader solar industry. More than 31,000 new solar jobs were created in the U.S. in 2014 bringing the total to 173,807—a 21.8% increase in employment since November 2013, according to a report released by The Solar Foundation. This is the second consecutive year that solar jobs have increased by at least 20%.

The solar industry is still dwarfed by the 9.8 million workers that the American Petroleum Industry says are employed by the oil and gas industry. However, the Solar Foundation is quick to point out the industry is starting to surpass some fossil fuel-related job categories. Solar already employs more people than coal mining, which has 93,185 workers, and solar has added 50% more jobs in 2014 than the oil and gas pipeline construction industry (10,529) and the crude petroleum and natural gas extraction industry (8,688) did combined, according to the Solar Foundation. One out of every 78 new jobs created in the U.S. over the past 12 months were created by the solar industry, representing nearly 1.3% of all jobs created in the country. Solar companies surveyed for the fifth annual census plan to add another 36,000 employees this year. “That’s just insane,” Rive says. “The solar industry is literally contributing to the job growth of the U.S. economy—and it’s just so understated.”

Third-party financing that allows homeowners to lease solar systems, a stabilizing manufacturing sector and utility-scale solar developers scrambling to finish projects before the federal investment tax credit drops from 30% to 10% on Jan. 1, 2017 has helped drive growth, says Andrea Luecke, president and executive director of The Solar Foundation.

The solar job-growth trend has spilled beyond the confines of companies solely dedicated to the renewable energy source. NRG Energy, one of the largest U.S. independent power producers and owner of 88 fossil fuel and nuclear plants, is expanding its solar business rapidly. NRG’s Home Solar group, the residential solar division of NRG Home, hired 500 people in the past 12 months and now has 1,200 workers.

“We’re growing explosively in several markets,” NRG Home Solar president Kelcy Pegler Jr. said in an interview with Fortune on Thursday following the company’s investor day presentation. As a result, Pegler’s residential home solar group plans to add “hundreds of jobs” this quarter and will double its current headcount in the next two years. NRG Energy, which employs 10,000 people, reorganized last year into three business lines: NRG Business, NRG Home and NRG Renew. The company has a number of other solar-related jobs within NRG Renew and NRG Home, including its power on the go division which was expanded after the 2014 acquisition of portable solar power company Goal Zero.

Overall, solar is one of the fastest growing segments within NRG Energy and the NRG Home group, a business unit that also includes the company’s electricity providers, home services, power on the go products and electric vehicle charging, Pegler says. Residential solar’s role in creating jobs is largely under appreciated by the public, he says: “These aren’t just part-time jobs either, these are careers.”

1. http://buswk.co/1yrpiez – BusinessWeek
2. http://for.tn/1u9tXQz – Fortune

The Good News Is . . .

• Consumer price inflation continued to decline on lower energy prices. Overall consumer price inflation fell another 0.4% in December after falling 0.3% in November. Energy prices plunged 4.7% after dropping 3.8% in November. Food, however, gained 0.3%, following a rise of 0.2% in the previous month. Excluding food and energy, consumer price inflation slowed to unchanged after a modest 0.1% in rise November. Inflation remains well below the Federal Reserve’s 2% goal.

• Schlumberger, Ltd., the world’s leading supplier of technology, integrated project management and information solutions to the oil and gas industry, reported earnings of $1.50 per share, an increase of 11.1% over year-ago earnings of $1.35. The firm’s earnings topped the consensus estimate of analysts by $0.05. The company reported revenues of $12.6 billion, an increase of 6.2%. Management attributed the company’s results to growth in its North American business and an improved operating margin.

• The AmerisourceBergen Corporation, a drug distributor, agreed on Monday to buy MWI Veterinary Supply for about $2.5 billion in cash, expanding into the animal health business. The company said it would pay $190 for each MWI share. MWI is the premier supply chain company in animal health, with leading positions in both the companion and production markets. Animal health is a growing market in the U.S. and internationally and is a logical extension of AmerisourceBergen’s pharmaceutical distribution and services businesses.

1. http://bloom.bg/1bidM2T – Bloomberg
2. http://www.cnbc.com/id/18080780/ – CNBC
3. http://bit.ly/1yaN3Wf – Schlumberger, Ltd.
4. http://nyti.ms/15cmdSO – NY Times Dealbook

Planning Tips

Tips for Understanding Market-Linked CDs

Low CD rates are pushing many consumers to think outside the traditional CD box. The result is that CDs linked to stock indexes are increasingly gaining traction. Called a market-lined CD or an index CD, its main appeal is that it is linked to an index that can potentially boost returns by participating in market rises. Their structure can allow investors to participate in the market’s upside without risking loss of their principal. However, these investments can be complicated and you should consult with your financial advisor to determine whether market-linked CDs are suitable for your investment portfolio.

Know what market-linked CDs are – A market-linked CD (MLCD is also referred to as an equity-linked CD, market-indexed CD or simply an indexed CD as well. It is a specific type of certificate of deposit that is linked to the performance of one or more securities or market indexes, like the S&P 500. Additionally, the term length is usually much longer, with periods ranging over many years rather than several months. They combine the long-term growth potential of equity or other markets with the security of a traditional certificate of deposit.

How market-linked CDs work – A Market-linked CD’s performance is dependent upon the performance of a market or index. As the market goes up, so does the CD’s potential return. Conversely, if the value of the market or index falls, the return on the market-linked CD will, too. Some issuers of market-linked CDs guarantee a base return to guard against a zero return should interest rates fall, though this is not always the case. There is a possibility of earning no interest during an economic downturn. Know the three important features of a market-linked CD that are important to be aware of when evaluating a market-linked CD:

• Participation rate – The participation rate is the percentage at which a market-linked CD’s annual return will correspond to the performance of the index it is tied to. For example, an index sees a 20% gain, but the indexed CD has a participation rate of 80%. The CD will produce a return of 16%, which is 80% of the 20% gain in the index. The participation rate can be below, at or above 100%.

• Interest cap – In order to protect a bank or similar issuing financial institution from paying too much in interest, a cap is usually placed on how much interest an investor can earn. Again, if the market-linked CD with a 16% return had an interest cap of 10%, investors would only earn a 10% return.

• Call risk – Many market-linked CDs have a call and liquidity feature. This allows the issuing bank to redeem the CD before it matures. The call price determines how much interest the investor earns. Many investors can receive a premium over par value when liquidating the market-linked CD.

Calculate the return – There are several methods that can be used to calculate a market-linked CD’s return. It is up to the issuing financial institution to determine how the rate will be computed. The two most common ways a market-linked CD’s return is calculated are averaging and point-to-point.

• Average – Rather than calculating the return based on a starting and ending point, the values of the index along several “observation points,” or dates, are averaged.

• Point-to-point – The return on a market-linked CD using this method is based on the difference between two points, or values. The starting point is the value of the index when the CD is issued and the ending point is the value of the index on a particular date just before maturity. The return can be the difference, or a percentage of the difference.

Understand the taxation – There are special tax implications of this particular investment that differ from traditional certificates of deposit. Usually, index-based investment income is taxed according to the rate for capital gains, which is limited to 20%. In contrast, returns on an index CD is considered interest income and taxed at the holder’s ordinary income rate. In addition, market-linked CDs owners have to pay taxes on “phantom income” on an annual basis, regardless of whether the CD has matured or not. Holding a market-linked CD in a tax-deferred account, such as an individual retirement account (IRA), can help you avoid paying taxes on earnings.

Evaluate the risks and benefits – Every investment has associated risks and benefits which you need to weigh against your financial goals. Below are some of the risks and benefits of market-linked CDs.

• Risk aversion – When an investor purchases an array of stocks, bonds, and mutual funds, there is nothing preventing a loss of every penny should markets plummet. However, most issuers of market-linked CDs offer principal protection. This means that the initial investment is protected from downturns in the market, but only when the CD is held until maturity.

• FDIC insurance – There are a few exceptions, but almost all market-linked CDs are protected by the Federal Deposit Insurance Corporation according to current guidelines. However, only the principal amount is insured and not the interest.

• Diversification – Market-linked CDs invest in more than one index or security which offers the opportunity for greater protection against market volatility.

• Limits on upside potential – While you are protected against losing your initial investment with market-linked CDs, the participation rate, interest cap and call provisions mean you will not participate to the full extent in the rise of the underlying indexes for these securities.

• Liquidity – Every investor faces a financial penalty if money is withdrawn from a certificate of deposit before maturity. However, because an indexed CD is tied to the market, early withdrawal becomes even more problematic. Any possible future return can be canceled out by early withdrawal penalties.

1. http://1.usa.gov/17VIB3I – FDIC
2. http://1.usa.gov/1sNBkfA – SEC
3. http://bit.ly/17VIJ3g – Bankrate.com
4. http://bit.ly/1ClQWql – Wikipedia
5. http://bit.ly/1BL7IBu – BuyUpside.com

Please don’t hesitate to give us a call if you need help with any component of your financial planning.

In the Headlines-January 30th, 2015
In the Headlines-January 16th, 2015

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